“Competition Demystified: A radically simplified approach to business strategy” authored by Bruce Greenwald and Judd Kahn

SUMMARY

While Michael Porter focused on various sources of sustainable competitive advantage, Greenwald & Kahn’s focus is on the strongest one – barriers to entry.

The authors start off by pointing out the key differences between strategic and tactical decisions. Strategic decisions are those whose results depend on the actions and reactions of other economic entities, while tactical ones can be made in isolation and are mostly dependent on effective implementation.

There are two strategic choices to be made, while competing:

where to compete, and
anticipate and, if possible, control responses of competitors.

A company not only competes against its direct rivals, but also against other players in the same value chain – for a share of the overall value created. But, squeezing the most out of the value chain for itself could be a recipe for a firm’s disaster (as Nintendo found out).

These are the salient features of a competitive situation:

Players – if it is not a short list, there is no barrier to entry
Actions – the range of actions that firms can pursue
Motives – some players just want to beat rivals, disregarding profits
Rules of the competitive game

Sources of competitive advantage

Of the Porter’s Five Forces, barriers to entry is the most important. “Incumbent’s competitive advantages” are synonymous with “barriers to entry”. Barriers to entry means that potential rivals cannot enter, and the incumbent can continue doing what others cannot – which is the essence of competitive advantage.

If there are no barriers to entry, there is no competitive advantage.

There are three key sources of genuine competitive advantage:

Supply-related (low cost producer, know-how)
Demand-related (customer captivity arising from habits, switching costs and search costs). Having relationships with multiple vendors is a good way to beat customer captivity from higher search costs. (My notes: I think, brand loyalty is also a form of customer captivity – people get habituated, and also face higher search costs. By higher search costs, I mean – customers feel it mentally and practically difficult to find another brand that can deliver the exact same experience as their current brand of choice. Brand promises are about consistency in delivery of usage experience. As Brent Beshore said: “You don’t trust the Coca-Cola brand, you know what to expect from them.”)
Economies of scale (lower fixed cost per unit). Economies of scale advantages require customer captivity. Else, entrants will capture market share. A firm with scale advantages can lower prices to a level where it only makes profits, ultimately pushing rivals out of the market. Another crucial advantage is that the bigger company can outspend rivals in terms of R&D, advertising etc. Economies of scale = High fixed costs + Customer captivity

A common theme in the last two is “customer captivity“, without which those advantages do not last long.

Incumbents enjoying economies of scale should be mindful of 3 critical factors while formulating strategy:

Defend current market position to retain scale advantages,

Size of the firm compared to the market is important, rather than absolute size,

Growth markets erode incumbent’s scale advantages from spreading fixed costs. Newbies will catch up fast.

Competitive advantages that lead to market dominance are local – in terms of geography, or product segment.

Large size and rapid growth of markets are liabilities for incumbents. Large markets can support multiple players. So, economies of scale are available to many companies. Rapidly growing markets do not have customer captivity – since a significant portion of customers are new.

How about being a pioneer in a market? Pioneering is a double-edged sword:

Advantage: Low variable costs on being ahead in the learning curve
Disadvantage: Manufacturing facilities built later are more efficient

In a fast-growing market, the advantages from being ahead in the learning curve will be short-lived. Rivals will also be producing large volumes – as such a market can support many players – and hence will also be learning fast and will catch up soon with the pioneer.

What should incumbents do?

Incumbents should identify the sources of competitive advantage, and continuously strive to intensify/ reinforce them.

There are three steps in assessing competitive advantage:

Develop an industry map,
Test for the existence of competitive advantages. High ROIC and stable & high market shares are evidences of existence of competitive advantage.
Look for sources of competitive advantage.

If there is no competitive advantage, focus only on being the most efficient – which is a tactical move. Efficiency. Efficiency. Efficiency.

Wal-Mart: How did they do it

Key learning from the case study:

Efficiency always matters
Competitive advantages – in this case, local economies of scale – coupled with customer captivity, matter more
Competitive advantages need to be defended
Supermarket profitability tracks local market share

All the players in the market benefited from:

increasing population
bargaining power with suppliers
technologies like bar code scanning

But, how did Wal-Mart capture the market?

Started operations in Arkansas and steadily captured local areas nearby which rivals ignored.
Spread from the center (Arkansas) into adjacent territories, and built new distribution centers to service the stores.

Wal-Mart way of ensuring customer captivity:

Low prices that competitors cannot match
High advertising, promotions and benefits that competitors cannot match
Good service levels

Wal-Mart way of leveraging local economies of scale:

Lower freight costs. Stores were within 300 miles of the distribution center. Also, trucks (owned by WM) were utilized efficiently – those which deliver goods to stores will pick up stuff from suppliers on the way back to the warehouse. (Efficient inbound logistics)
Lower loss on shrinkage (lost, broken and pilfered goods). (Efficient inbound logistics).
Low advertising cost per dollar revenue, due to regional concentration.
Managers spent more time in stores (thanks to concentration of store locations, less time was lost on travel), asked for opinions from employees, rewarded employees for meeting/ exceeding targets.

Coors: Lost out to AB

Learning: Straying from regional focus into expanding widely ended up badly.

Coor’s advantages:

more integrated than competitors, and efficiently run
non-unionized labour

Coor’s disadvantages:

Too much self-reliance led to lack of scale advantages in packaging, can & bottles, as well as energy sources. Also, management attention was spread very thin – being involved in a lot of activities.
Operated only one brewery where capacity was well beyond efficient brewery size. This led to higher transportation costs and storage (since they sold non-pasteurized beer), as they expanded geographically.

Compaq and Apple as computer box makers (till 2005)

In the computer business, barriers to entry exist only in:

Operating systems – Windows
CPUs – Intel

The above barriers are due to:

high customer switching costs
high spending by incumbents on R&D and production technology
economies of scale
network effects – which further enhances customer captivity and economies of scale

Box makers were at disadvantageous position in the industry:

only OS and CPU mattered
they were basically assemblers – not too much of value creation at their end
did not have high fixed cost/ low marginal cost to take advantage of scale
due to infrequent purchase by end customers, there was no habit formation

Compaq:

Strategy: High quality, high price strategy -> focused on corporate customers who cared more about reliability than price.
Initially had quality and scale advantages (till the ’90s) and thereafter focused on efficiency
Had failed M&As, lost focus, and sold out to HP in 2002. End of story.

(However, as we know, the Apple story turned out to be much different after this book was published.)

Philips as a pioneer in the CD market

Learning: Pioneering does not guarantee success. Quick market growth helps entrants to learn fast and acquire scale advantages soon.

Philips pioneered commercial production of CDs
No barriers to entry. Had no patent for CDs. Scale advantages were absent, as minimum efficient size was just 2 million discs/ year.
Customers were big, powerful record companies.
Did not benefit from CD player business also. It took very little time for rivals to bring CD players to the market

Cisco ruled the router market

Learning: High fixed costs + Customer captivity = Scale advantages

High software content lead to high fixed costs
Customer captivity – Routers were complex equipments and routers of different manufacturers were incompatible (at that time)

COMPETING ON PRICE: Prisoner’s dilemma/ Game theory

Competing on price is the most destructive form of competition. How to avoid it?

Stay out of each other’s way – product lines, geographies. Avoid directly taking on the rival. This will help in spreading costs over a large revenue base, rather than dividing the revenue between players.
Customer loyalty programs – (a) cumulative rather than current purchases, (b) increasing rewards as volume increases.
Competitors agree on limits on output capacity (e.g., OPEC). Should have high barriers to entry, without which entrants will thwart these plans.
Most Favoured Nation (MFN) clause in pricing contracts. In such a case, cost of customer acquisition will be higher than gains from it. Aggressive price cuts will impact the entire customer base.
Agree to limit purchasing and pricing decisions to a specific and narrow window in time, so as not to let customers play suppliers against each other.
Employee/ management reward system within the competing firms to depend on profits, rather than volume.

All these should be done while avoiding anti-trust actions. This is possible if there is a dominant firm that emphasizes profits over market share or sales volume.

How to respond tactically to deviating firms?

Two components are needed in a reaction to deviating rivals, so as to make them work in the firm’s favour:

React to competitors price reduction, and
Signal of willingness to return jointly to higher prices

Such tactical responses can be automatic:

“best in the industry price contracts” reimburse customers, if competitor verifiably offers lower price
“meet or release contracts” also are automatic, except in cases where the rival’s price will cause losses to the firm

The firm should respond to rival’s actions. Else:

it is a recipe for disaster (loss of customers)
rival will think that price cuts will always work, destroying profits further

Selective responses rather than blanket is better. Such companies will have higher profitability. For example:

Keeping the good customers, while letting the rivals take the rest (e.g., banks keeping customers with good credit quality, while letting aggressive competitors take the lower quality ones which leads to asset quality problems in the future).
Pick their spots. Attack rivals where they are stronger, thereby inflicting more damage. Cutting prices in markets where the firm is dominant will cause more losses to itself.

But, what if you are the customer, and suppliers are co-operating among themselves?

seek private, non-transparent price arrangements
deal with suppliers individually, concentrating business with deviating firms
co-operate with large customers to undermine industry co-operation

Coke vs Pepsi

Coca-Cola’s competitive advantages were:

Customer loyalty (captivity)
Economies of scale (both in making concentrates, as well as bottling businesses) – in advertising, new product development, and regional scale economics as water is heavy and transport is costly.

Coke competed with Pepsi on price and product, but later went into co-operating mode.

Price cuts. Coke cut prices where it was dominant, causing more damage on itself than Pepsi.
Products. New Coke (sweeter) introduced to replace the Original Coke. It backfired, and the Original was reintroduced as Classic. Later, New Coke was used as a weapon against sweeter Pepsi, vying in the younger generation’s market. Now, potential co-operation between Coke and Pepsi became possible as Pepsi felt threatened.
Co-operation. Coke spun off the bottling division and loaded it with debt, requiring it to make profits to service the obligations. This signaled co-operation with Pepsi, and focus on profits rather than relentless battle for market share. Pepsi responded by dropping the Pepsi Challenge and toned down the advertising campaign. Consequently, operating profit margins of both companies went up. Pepsi spun off the bottling units much later.

COMPETING ON QUANTITY: Entry/ Preemption game

Incumbents will try their best to prevent entrants from getting established, trying to restrict market supply. How to stay clear of incumbents’ wrath?

Strategic approaches for the entrant – Minimizing the cost of accommodation:

Avoid head-to-head competition in products and markets
Proceed quietly, one small step at a time
Let the incumbents know that entrant is moving into only one market, not all the ones the incumbents dominate, and that it is unique among other potential entrants
If there are a number of incumbents, newcomer should try to spread the impact of its entry as widely among them as it can. Then, the newcomer is hard to kill, as no incumbent alone can deliver a mortal blow, and also might invite aggressive response from existing rivals.

Kiwi enters the airline industry without competitors attacking

Kiwi was founded by ex-airline employees who wanted to make a better airline.

Kiwi was unique. The company was funded and run by pilots and flight attendants. So, it was difficult to eliminate because their lives depended on it and were passionate about it.
Kiwi did not compete directly with competitors on routes, timings, customer segments, human resources, or price. It also ensured that its threat to big airlines were minimal – as it had comparatively very few seats on each route.
Kiwi did not promote much on media. Rather, the ‘Kiwi story’ got much press coverage.
Labour costs were lower, because employees themselves were the owners – and hence were willing to take pay cuts when there was trouble. Furthermore, these employee-owners were loyal than people who worked just for the salary.
Kiwi never looked like it had grand plans for expansion.
If competitors wanted to fight Kiwi, it looked like they had much more to lose than Kiwi. Kiwi was difficult to eliminate by a single rival – due to small size and employee-owner model.

Later in its story, Kiwi went into bankruptcy – as it lost focus on its proven strategies once it expanded.

Polaroid pushes Kodak out of the instant photography market

Kodak’s core personal photography market was slowing, and it wanted to enter the instant photography market dominated by Polaroid. In the end, it lost out to Polaroid.

Polaroid had these advantages:

Proprietary technology (patent)
Customer captivity (need to buy Polaroid films once the camera is bought), to some extent
Economies of scale (high capex and R&D)

What Kodak did:

Made big publicity of its upcoming entry into the industry.
Infringed Polaroid’s patents.
Did not consider the near-certainty of aggressive response from Polaroid. Polaroid’s founder (Edwin Land) was emotionally focused on the segment, and the company was not into anything else.
Kodak could not keep up the production in line with demand, driving customers to Polaroid.

Book summary: Competition Demystified